‘The single largest factor in the failure of small businesses – up to 80% of all cases – is poor cashflow management.’ Peter Denton from Lothbury Business Management gives us the lowdown on how a robust financial model offers invaluable insights into a startups’s health, future prospects, and potential pitfalls. Crucial ingredients in winning over potential investors.
Why is Financial Modelling important?
Financial modelling is a critical part of understanding the health of a business, projecting what the company can expect to achieve over a future period. It also offers validation to investors around fundraising and investment. As part of normal operating practice, it should be a key tool that feeds into the strategic decision-making, planning and risk management processes. It will assist a business in identifying peaks and troughs in cashflow prior to them occurring.
By dedicating time and effort to incorporating a realistic and robust financial model into the long-term planning of a growing business, five key benefits can be achieved.
1) Business Value and Fundraising
First and foremost, a robust financial model can both highlight the current value of a business, but also conservatively project where the company can expect to be at certain points in the future.
This is critical to being able to convince investors that the business is being operated effectively, and that there is a strong and reliable return that can be achieved from their investment. Securing funding to drive business growth relies on quantifiable metrics and realistic forecasting, so ensuring the model is rational and pragmatic is key to securing the funding needed to move forward.
2) Cashflow Management
Understanding cashflow, and the factors and levers that might impact it, should be at the forefront of every startup’s strategic planning. Businesses fail for many different reasons, from not properly understanding product market fit, to overpricing, to poorly executed marketing plans. But the single largest factor in the failure of small businesses – up to 80% of all cases – is poor cashflow management.
Ensuring financial models are properly structured and reviewed frequently will give a business an understanding of pinch points, along with the ability to mitigate them well in advance of problems crystallising.
3) Decision-Making and Risk Management
All businesses have their own metrics against which they determine success. It might be turnover, number of new customers, or something more abstract like social media impressions. No matter what those core metrics are, the financial model will deconstruct them into something more measurable.
This in turn will enable a company to make more informed decisions about the business health, and provide insight into the potential impact of strategic decisions like acquisitions, capital investments or expansion plans. In addition, a properly constructed financial model will enable a business to understand the potential risks associated with specific approaches and market conditions, and provide the ability to stress-test scenarios before committing to a course of action.
4) Resource and Capital Allocation
Models will be the primary tool used in understanding where and (where not to) commit capital. That could be in terms of pure investment into a product, service or strategy, or simply the human cost of executing a delivery.
Regardless which it is, the financial model will be key in determining what outcomes a company can expect, whether they meet the wider strategic goals of the business, and ultimately whether or not to proceed with a decision or event.
Along with cashflow management, it is a key driver in determining the timing of projects, deliveries and engagements, as well as the scheduling of major purchases or commitments.
5) Strategic Planning
Whilst the primary goal of financial modelling is to predict what might be coming next, it can also shed significant light on how financially stable a business is currently.
These insights will help guide important strategic decisions, such as entering new markets or launching new products. As a result, modelling should not only be a forecasting tool, but also a measuring stick to assess the company’s performance over time.
With this information, a business can compare projected performance with actual results, enabling a judgement to be made on longer-term goals and expectations, as well as helping the company adjust its strategies and improve financial outcomes.
Whilst it might sound daunting, most businesses can greatly improve even short-term outcomes by committing time to reviewing the current state of their modelling, whether it is accurate, realistic and achievable, and what factors should be considered to improve results going forward.
Lothbury is a specialist in helping businesses scale, from strategic guidance and
tactical planning, to technology execution and operational outsourcing, they
have become the go-to problem solver for growth companies in the UK.
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